Negotiating a Tenant Retail Lease

September 15, 2010No Comments

Tenant leases are a tricky thing with lots of complicated phrases and boiler plate paragraphs. One of the most important things when negotiating a lease is let the professionals in your court help you to negotiate the lease; it’s what they do for a living. Do you have a good accountant? Do you have a good attorney? Do you have a good insurance agent? Do you have a good commercial real estate broker?
The first important person in this line of professionals is your accountant, he/she is the one who is going to identify what you can and can’t afford as to how all the numbers play into your overall financial picture. Most will say that anything higher than a 12-15 percent (of total gross income) is a huge risk and should not be undertaken. Granted, the economy is in your favor, however, I’m still seeing leases that are signed in excess of 15 percent. What we all have to rationalize is that we can’t want something so bad that we are willing to do anything for it.
The second most important professional in line will be your commercial real estate agent. They work for you and the best part is they get paid by the landlord, where is there a better deal than that? You are going to want to sign an exclusive agency agreement with the agent’s firm, and then you are off. The agent will know what the going rates are for most places and what the market will bear based upon the current market conditions.
Fortunately enough, the market is in our favor, there are so many empty big boxes due to the collapse of Circuit City and Linens and Things that you pretty much have the pick of the lot. The same is true for strip shopping centers and mall locations. Just because a space is empty doesn’t mean that it’s the best location. If the space is empty for reasons other than a national close, find out why the space was not successful.
An entertainment venue is a very desirable business for a landlord, we will lease a lot of space and we will attract a lot of customers since we are a destination location, therefore, approach your negotiations with the confidence that you are doing the landlord a great service by picking their space. Know the amount you are willing to pay per square foot, what increases your business can tolerate on a yearly basis and how long do you want your first term to be, along with lease renewals and intervals for additional terms. Before you spend any time with a landlord allow your agent to do some digging to find out how long the space has been empty, what the zoning allows, how much they are asking per square foot, what they are offering in tenant fit-up allowance per square foot, how much free rent or rent abatement they will offer, and what the landlord requires in collateral, personal guarantees and securitization. As the agent reviews these items with the landlord other issues about the space will emerge. Tenant fit-up allowance is the amount of money the landlord is willing to provide for you to construct the space. Remember, this is not free money, the landlord is going to add their payback of this in what they are asking for in rent and will dictate what the increases are over the term of the lease. Typically, with a brand new space, you will be able to negotiate the highest tenant allowance, whereas, in a second generation space much less, if any at all. Always be actively looking at more than one location because inevitably one will fall through. If you are looking at multi-use locations such as a strip center, mall location or the new urban life style centers, the anchor tenant will have the right to decide what type of business they will allow, one that complements their business and does not compete with it.
Once you have investigated all of the items listed above and found a favorable location, your commercial agent will prepare what’s called a letter of intent (LOI.) This is what’s called your due diligence period, it also allows you to tie up the space so that the landlord cannot negotiate a lease with anyone else during this timeline. Sometimes landlords will ask for earnest money to hold the property during the LOI period while others will require your earnest money to be non-refundable. Do not sign a non-refundable earnest money agreement! The LOI will outline most of the major terms that will appear in your lease. This is the best time to negotiate all of the critical terms that will make your business and any contingencies that you need to operate your business to its fullest. Additional items in the LOI will include the use of the walkway outside your business for a patio with tables. This is free space and will help to generate additional revenues in food and drink. Also included will be valet and employee parking, who pays the maintenance contract on the HVAC units and who pays when they need to be replaced, the term of the lease and renewal options, the price for taxes, insurance and common area maintenance and a marketing per square foot cost if you are in a space that is a part of something bigger. All landlords will pass off as many expenses to the tenants as possible; this is called a triple net lease.
Contingencies are built into a LOI as your safety net. Potential contingencies could be: acquiring the needed financing, verification of zoning or the ability to rezone the space, getting a liquor license (if applicable), the landlord getting permission from their anchor tenant for your use, getting building permits, etc. Take your time on the LOI to make sure you get everything in it that you want and don’t be afraid to walk away if you don’t get it. This is one of those times that you identify to yourself that you can’t want it so bad that you are willing to do anything for it. All too often I have seen leases that have strangled the tenant because of poor decision making in the beginning.
On to the actual lease document once all contingencies have been met in the LOI. You and your agent will review the document to make sure all the conditions set forth in the LOI are transferred to the lease. Your agent will be looking for broad issues the make up your lease where it could be as simple as the context of a word or holding the landlord accountable and liable for the same things they are asking of you. The next to review the lease will be your insurance agent to make sure that the landlord isn’t requiring more insurance and dollar limits than what is necessary to insure your business and what is fair in covering the landlord as a co-insured. Once all three of you have gone through the lease with a fine tooth comb, then it’s time to send it to your attorney to evaluate your overall exposure and to manage the legal jargon in your favor as best as possible.
This overall process could take as long as a year or more depending upon the motivation of the two parties. Don’t jump into an LOI too soon as the capital contingency that the landlord may require will expire before you have secured the necessary funding either through investors or an institutional fund.
Even if you have negotiated leases before, make sure you seek the assistance of professionals in their field to assist you in lease negotiations, it goes a long way from exposing you to any or limited liability.
(Industry Owl Alan Fluke is the president of AEA Management Group. Reach him at afluke@nc.rr.com or visit www.alanfluke.com.)

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